Kickbacks in Defence Procurements

Kickbacks in Defence Procurements

(FORCE Jan 2015)

Major General Mrinal Suman

Allegations of corruption have been the bane of India’s defence procurement regime. The saga of dishonest dealings is as old as the history of Independent India. Since the infamous jeep scandal of 1948, every major defence deal has been dogged by allegations of kickbacks, controversies and enquiries. It is generally believed that speed money is essential at every stage of the process. Worse, it is disconcerting to hear foreign vendors claim that their commercial quotes cater for such ‘overheads’.

The US Government estimates that defence sector accounts for almost 50 per cent of all kickbacks in the world, although the arms trade accounts for less than 1 per cent of the international trade. Even though India’s defence imports constitute a very small portion of the world trade, it has come to acquire notoriety for sleaze and corruption. Lack of probity and transparency in defence procurements has been attracting intense media attention. The environment is convinced that the procurement process can be conveniently skewed by decadent decision makers for a price.

Demonstration of ‘the highest degree of probity and public accountability, transparency in operations, free competition and impartiality’ continues to be the stated aim of the Defence Procurement Procedure (DPP). The government has been claiming credit for introducing innovative provisions to check misdemeanours. Two major measures are often cited.

One, a system of internal scrutiny of the technical evaluation process through the constitution of Technical Oversight Committees was introduced for all major procurements in 2002. Two,  signing of an Integrity Pact between the government and the vendors was made mandatory for all procurements over Rs 100 crores in 2006. Under the pact, both sides undertake not to accept and offer bribes respectively. It was claimed that the provision would make the whole procurement process corruption-free. The environment was euphoric. However, the exultation was totally misplaced. It was naïve to believe that the officials who were not scared of punitive legal provisions would be deterred by an honour-code commitment. Soon it was business as usual.

It needs to be recalled here that the contract for the VVIP helicopters was signed in February 2010, after in-house scrutiny by the Technical Oversight Committee. The contract had the much trumpeted Integrity Pact as well. Yet, the whole process was so vitiated and sullied that the Comptroller and Auditor General was compelled to observe that ‘the entire process of acquisition posed serious questions on accountability and lack of transparency in the finalisation of contract’.

The Convoluted Procedure

DPP has been revised a number of times since 2002, with the ostentatious claims of making it sleaze-proof. If that be so, how come scams continue to take place with unremitting regularity? An understanding of the procurement procedure is essential to appreciate its vulnerabilities to the corrupt practices.  

15-Year Long Term Integrated Perspective Plan (LTIPP) and 5-Year Services Capital Acquisition Plan flow from the 15-Year Defence Capability Plan prepared by Headquarters Integrated Defence Staff. Annual Acquisition Plan (AAP) of each service is prepared by the respective Service Headquarters. Requirement of funds is projected as per the anticipated outflow on the schemes as per their inter-se priority in AAP. 

All procurement proposals are categorised and sub-categorised by the Defence Acquisition Council (DAC) to spell out the precise route to be followed. Request for Proposals (RFP) are issued to all competent vendors. Following ‘Single-stage two-bid’ system, vendors are asked to submit technical and commercial proposals in separate sealed envelopes. Technical proposals are opened on the due date while commercial proposals are kept sealed in safe custody in the Ministry of Defence (MoD). After technical evaluation (including field trials and staff evaluation), technically acceptable vendors are shortlisted. Thereafter, their commercial bids are opened to determine the lowest compliant bidder for negotiating the contract.

Although DPP is an exhaustive and elaborate document covering all stages of the procurement process, it possibly cannot cater for human ingenuity for finding/creating loopholes for corruption. It will be apparent as we proceed. The case of VVIP helicopters has been repeatedly cited as it is symptomatic of the clever ploys through which the whole process is tweaked by the unscrupulous.

Susceptibility of the Procedure to Corruption

An urgent procurement proposal can be initiated for the purchase of items that are being manufactured/marketed by a ‘friendly vendor’. In other words, artificial demand is created to have the favoured proposal included in AAP. Further, priorities are skewed to accord higher precedence to it as funds are always insufficient to cater for all proposals. This is achieved through an unholy connivance between the user directorate and the operations directorate.  

Recurrent generation of demand for TATRA vehicles is an example of the above stratagem. As the vendor was obliging all decision makers, it had become an annual ritual. Requirements were inflated to increase the amount of kickbacks. In September 2010, the then Army Chief was allegedly offered Rupees 14 crores to clear procurement of 1600 TATRA vehicles. He declined. Apparently, the vehicles were not urgently required as no procurements have been done since then. It was a patently sham demand to place orders on BEML for illegal gains.  

Qualitative Requirements (QR) that define essential performance characteristics of the equipment being sought are often manipulated to favour a chosen vendor and eliminate competition, thereby effectively creating a single-vendor situation. It is one of the most commonly prevalent practices as QR are always subjective in nature and are based on perceived operational scenarios. 

In the infamous case of VVIP helicopters, two critical parameters were introduced to favour the chosen vendor. The first one related to flight ceiling. It was reduced from the earlier 6,000 to 4,500 meters as the ‘favoured helicopter’ was certified to fly up to an altitude of 4,572 meters only. Secondly, minimum cabin height was increased from 1.45 to 1.8 meters. It effectively ruled out all competition as only the ‘favoured helicopter’ complied. Thus the very concept of QR was unethically tweaked for kickbacks.

Field trials are by far the most critical aspect of the technical evaluation process. These are carried out under the aegis of the concerned Service Headquarters (SHQ) and are required to be conducted in all conditions where the equipment is likely to be deployed, to validate performance claims made by the vendors with respect to compliance with QR. It implies that the equipment on offer must be subjected to the trials under actual terrain/climatic conditions.

Manipulation of field trials poses the biggest threat to the integrity of the whole procurement system. In the case of VVIP helicopters, against all norms, trials were carried out on a substitute helicopter as the helicopter offered by the favoured vendor was still in the developmental phase and not ready for trials. What is worse, the trials were not held in actual terrain/climatic conditions in India but in the vendor’s factory abroad. Shockingly, the helicopter was declared fully QR-compliant and approved for induction.

Another common ploy is to ‘persuade’ trial units and intermediate commanders to raise irrelevant issues to generate doubts about the efficacy of competing equipment on specious grounds and seek retrial. There are many aspects like driver’s comfort that are descriptive in nature and cannot be quantified. Reports on such parameters can be easily managed by smart vendors through undue influence. Another subterfuge commonly employed is to over-emphasise importance of the strong points of the favoured equipment while highlighting every small weakness of the competing items to show them in poor light.

Evaluation by the General Staff (GS) is the final step in determining whether the equipment is technically acceptable or not. With inputs from numerous agencies, performance parameters of favoured vendor are highlighted and failings downplayed. On the other hand, weaknesses of competing vendors are underlined and thus declared unacceptable. At times, GS evaluation goes to the extent of seeking wavers of essential parameters for the favoured equipment on baseless grounds.

One of the commonest ways of seeking more kickbacks by the officials is to increase the quantity required after fixing ‘percentage of cuts’ with the successful vendor – higher the value of the contract, higher the quantum of kickback. It is done either by increasing the quantity in the original contract or by invoking option clause or by placing repeat orders. In the case of VVIP helicopters, the initial quantity of 8 helicopters was subsequently increased to 12 without any justification. Increase in quantity resulted in an excess expenditure of Rs 1,240 crore. The quantum of additional kickbacks can well be imagined.

Another standard practice is to demand inclusion of ancillary sub-systems after the identification of the lowest bidder. It makes a mockery of the much trumpeted ‘single-stage two-bid system’ and provides a windfall opportunity to the vendor to quote any price that it wants for the add-on items. Normally, a smart vendor always keeps his unit cost price at competitive levels but charges exorbitantly for add-ons at a later date in connivance with the officials concerned. The loot is shared by all.

In the case of VVIP helicopters, demands for Traffic Collision Avoidance System, Enhanced Ground Proximity Warning System and Medical Evacuation System were added-on while the commercial negotiations were in progress. It was a patently decadent and gratuitous step. It is not understood as to why these requirements could not be foreseen before the issuance of RFP in September 2006.

Once technical and commercial processes are completed, the case is forwarded to the competent financial authority (CFA) for his final approval. No contract can be signed with the successful vendor unless CFA accords sanction. CFA can delay grant of approval or even let the whole case lapse. As the stakes for the successful vendor are exceedingly high at this stage, his desperation to clinch the deal is exploited to extract huge kickbacks by political leadership and top MoD officials. This is perhaps the most vulnerable stage of the entire procurement process.

FMS Route is not above Board

Starting with the procurement of 8 AN/TPQ-37 Fire Finder counter-battery artillery radars in 2002, India has been increasingly resorting to purchases from the United States through the Foreign Military Sales (FMS) route. The single most important reason cited repeatedly in favour of this route is that being government-to-government deals, they are above board and free of all extraneous influences. As a matter of fact, this is a most fallacious logic as it totally ignores the devious activities that precede selection of FMS route by a country.

To coax Indian decision makers to shed open competition and opt for single vendor FMS route requires considerable persuasive skills, networking and even ‘sweeteners’. To start with, efforts are made to influence the decision making apparatus, either through social circles or bribes or through the lure of green cards for the progeny of the key officials. To generate favourable media treatment, members of think tanks and media are taken to visit their factories and ‘looked after’.

Alongside, efforts are made to torpedo every attempt at procurement through competitive route. Seeds of doubt are sown about the competitors in the minds of public through planted stories and third-party complaints. The aim is simple – eliminate all competition by having them blacklisted through selective leaks and innuendoes. Slowly a stage is reached when the buyer country is forced to opt for FMS route for its emergent requirements.

It is interesting to note that the US has been considerably successful in ensuring that all helicopter requirements of the Indian armed forces are met by the US machines. Over the last one decade, it has managed to stall purchases from other countries.

Offsets Provide Huge Scope for Corrupt Practices   

     

Perhaps no other feature of India’s defence procurements is as prone to corruption as the provisions relating to offsets. Offsets present huge opportunities for unethical practices. There are a number of reasons for the same.

One, although offset contracts are signed concurrently with the signing of the main contract, inadequate attention is paid to their drafting. Provisions are spelt out in imprecise and vague terms, leading to subsequent multiple interpretations and resultant confusion. Invariably, small print favours vendors, adversely affecting the interests of the buyer country.

Two, as offset contracts are related to main defence contracts, they are, most unjustifiably, accorded the same security classification as the main contracts. Secrecy breeds a culture of non-accountability. Thus, opacity of offsets provides an ideal playground for corruption.  

 

Three, implementation of offsets remains poorly supervised. Officials possess little expertise and knowledge to comprehend and manage highly complex offset technicalities, providing considerable opportunities to vendors to manipulate the system to submit inflated and falsified performance reports. 

Four, the offset policy grants discretionary powers to overseeing officials to cater for unforeseen eventualities. Such powers are a major source of kickbacks. When money involved runs into millions of dollars, potency of discretionary powers becomes mindboggling.

Finally, there is a distinct possibility of routine commercial activities and trading being shown as offset programmes to earn credits. For example, in the case of the VVIP helicopters, sham services were shown against offset obligations. Such practices deprive India of genuine offset benefits.  

Conclusion

The biggest weakness of India’s defence procurement regime is the secrecy that envelopes it. Unfortunately, Indian military’s proclivity for secrecy aggravates the problem. Their misplaced sense of security-consciousness makes them assign unduly high security classification to every procurement proposal, with the result that the whole process remains shrouded in mystery. It provides an ideal environment for the corrupt to shortchange the system through their ingenuity for finding/creating loopholes for illegal gains.

Secrecy and probity are anti-thesis of each other. While secrecy breeds corruption, transparency inspires confidence in the environment about the uprightness of the complete process.

Although the initial euphoria has abated considerably, offsets continue to be an exciting proposition for many. As the offset pie is expected to be worth over USD 20 billion during the next ten years, it is essential that the government pays attention to the management of offsets.  Offset contracts should be meticulously drafted and every single detail should be available in the public domain.

As stated above, it is a misnomer that all FMS deals are above board and free from taint. The very fact that decision makers are prevailed upon to forego open competition (with associated cost, quality and delivery advantages), and opt for single vendor FMS route, raises questions of propriety. It is not that FMS route should be totally shunned. It should only be adopted to procure cutting-edge equipment that is unavailable from any alternate source.

Finally, corruption involves two parties – bribe giver and bribe taker. Since the exposure of the jeep scandal, no official has ever been punished for taking bribes. Defence Minister A K Antony told the Parliament on 16 December 2013 that no official had been found guilty in 23 cases registered by CBI since 2010. If that be so, to whom did the vendors give bribe? Why have a number of companies been blacklisted for misdemeanor? Why have so many contracts been cancelled for alleged irregularities, the case of helicopters for VVIPs being the latest one? The environment continues to wonder.*****

Need for Reforming the Defence Budgeting Regime

Need for Reforming the Defence Budgeting Regime

(DSA Feb 2015)

Major General Mrinal Suman

Budget time is crystal gazing time. Every expectation is based more on hope than ground realities. For the services, budgetary allocation has three major connotations. One, it sets the pace of modernisation of the armed forces. As is well known, India’s defence modernisation plans are lagging behind by more than a decade with close to 50 percent of the inventory having outlived its useful service life. Two, it demonstrates government’s commitment to national security through the allocation of necessary resources. Finally and most importantly, budget has a profound effect on the morale of the soldiers. It conveys to the services that necessary wherewithal will be made available to them to defend the country, and that, they will not be made to fight another Kargil War with ‘whatever we have’.  

For the Ministry of Defence (MoD), the Finance Division prepares the defence budget and estimates for the defence services, civil estimates and defence pensions. The defence budget consists of two heads – revenue and capital heads.

According to Rule 91 of General Financial Rules 2005, all charges for maintenance and working expenses (including pay and allowances), expenditure on working and upkeep of the projects, renewals/replacements and additions/improvements/extensions should be debited to the revenue account. Thus, revenue procurement implies procurement of items and equipments to maintain and operate already sanctioned assets. The Defence Procurement Manual contains policy guidelines for revenue procurements.

By virtue of the fact that India has a large standing military, nearly 65 percent of the revenue budget is consumed by pay and allowances. This expenditure is likely to rise further with the raising of a mountain strike corps, resulting in an accretion of 80,000 soldiers. After catering for expenditure on other essentials like rations, clothing, fuel, transportation and critical spares; limited funds remain available for ammunition, spares, stores and maintenance of assets.

On the other hand, capital head covers all significant expenditures incurred with the object of acquiring tangible assets of a permanent nature or enhancing the utility of the existing assets. Further, as per Rule 91 (a) of General Financial Rules 2005, all charges for the first construction and equipment of a project as well as charges for intermediate maintenance of the work while not yet opened for service shall also be dealt with as capital expenditure. Capital procurement would, therefore, mean procurement of all goods and services that fit the description of capital expenditure. The procedure for capital procurement is laid down in the Defence Procurement Procedure. As all modernization plans are dependent on the quantum of resources available under the capital head, it is of critical importance and has been discussed in detail here.

Convoluted Budgetary Exercise

Preparation of the defence budget is a highly disjointed and cavalier exercise. Once the capabilities required by the services to achieve the objectives set-out in the Defence Planning Guidelines are spelt out, a Defence Capability Plan covering 15-years time span for attaining the desired capability is prepared. The 15-year Long Term Integrated Perspective Plan (LTIPP) flows out of the Defence Capability Plan and covers systems required by the services to meet each of the stated defence capability.

LTIPP is further broken down into five year plans called Services Capital Acquisition Plan (SCAP). It must be mentioned here that both LTIPP and SCAP are prepared without taking into account the funds likely to be made available to MoD. In other words, these plans are mere wish lists with no assured financial support.

Annual Acquisition Plan (AAP) of each service is a two year roll on plan for capital acquisitions and consists of the schemes included in SCAP. The draft AAP is prepared in two parts. Part A comprises carry over schemes from AAP of the previous year and approved schemes.  All new proposals are included in Part B. Requirement of funds for capital expenditure is accordingly worked out service-wise. More than 90 percent of the capital budget goes on committed liabilities, leaving little for fresh acquisitions. It is the most worrisome aspect of the whole exercise.

Proposals submitted by the services are aggregated at Headquarters Integrated Defence Staff (HQ IDS). MoD merely compiles the lists and forwards them to the Ministry of Finance (MoF) for incorporation in the union budget. As stated earlier, in the absence of assured funds support, the lists prepared by the services are highly ambitious. They are based more on aspirations than realistic estimations.

On receipt of allocations from MoF, MoD sub-allots funds to the services and other departments. As funds allocated are always far less than the demands, the services get forced to prioritise their requirements for different budget heads. All fresh procurement proposals of AAP get re-examined and scrutinised for determining their inter se operational urgency and likely cash out-flow during the current financial year.

One of the oddities of the Indian dispensation is that closer to the end of a financial year, efforts are made by MoF to withdraw unspent funds from all ministries to reduce fiscal deficit. As the Finance Division of MoD functions under the fiscal directions of MoF, it does not clear/concur any major expenditure unless given a green signal by MoF, thereby forcing MoD to surrender funds. Worse, MoD gets blamed for not spending the allotted funds. The environment fails to notice the ploy of MoF. 

    

Another aspect that deserves mention here is the fact that there is no system of carrying forward the unspent funds to the next financial year. Surrendered funds lapse and go to the kitty of MoF. Such a policy has strange fallout; every ministry tries to expend all allotted funds. Closer to the end of a financial year, it is always a race against time. Many times funds are spent imprudently on lesser requirements, only to avoid their surrender.

  

Expectations from the Forthcoming Budget

Unquestionably, the first issue of concern relates to the size of the defence pie in the forthcoming budget. It is fervently hoped that the defence allotment gets close to 3 percent of GDP. Presently, the state of operational preparedness of the armed forces is alarming. The current profile of equipment held is dismal. Instead of 30 percent state of the art equipment, the holding is mere 15 percent. More worrisomely, 50 percent of the inventory needs emergent replacement. Therefore, funds allotted under the capital head will be the main concern of all those who are concerned with the current ‘hollow’ state of the armed forces.

Modernisation of the armed forces is going to be a herculean task, requiring commitment of over USD 100 billion. In addition to regular upgradation plans, India will need to make up the existing deficit of 15 percent of the state of the art equipment. India is implementing many ambitious projects like Future Infantry Soldier as a System; Network Centric Warfare; Tactical Communication System; aerospace capability systems; night-fighting equipment; and simulators. These force multipliers are highly cost-intensive. 

   

As the entire dated inventory cannot be replaced in a short period, upgradation of equipment to increase its useful service life is a commonly exercised option. Some of the major upgradation programmes involve tanks, artillery guns, anti-aircraft weapons, helicopters, fighter aircraft, fire control radars and submarines. The list is indicative and not exhaustive. These projects are likely to entail an expenditure of up to USD 10 billion.

Concurrently, the government needs to rationalise and streamline the whole budgetary planning process as well. A public version of the perspective document, outlining the Technology Perspective and Capability Roadmap (TPCR) covering a period of 15 years was issued by HQ IDS in April 2013. TPCR is a derivative of LTIPP and delineates the envisaged capability roadmap for all components of the armed forces. In the absence of assured financial support, preparation of LTIPP and TPCR is considered to be an academic, speculative and conjectural exercise, without any credibility.

The sole objective of issuing TPCR is to give adequate advance notice of impending procurement proposals to the industry to facilitate considered investment decisions and explore avenues for the development/acquisition of required technologies. However, industrialists do not base their investment decisions on the projections that lack assured commitment of funds and are prone to frequent changes.

Therefore, it is essential that MoF indicates likely budgetary support to MoD for the plan periods. Such a step would ensure that the perspective plans are not made in a vacuum.  It will also help the services in fixing priorities ab-initio, as per the likely availability of funds.

As was done at the end of the last financial year, MoF has ordered a cut of Rs 13,000 crore in the capital outlay for the three services in the current fiscal (2014-15). Such a cut impacts the modernisation plans adversely with cascading effect. As it is, the capital budget is always grossly inadequate and the bulk goes into meeting the committed liabilities, leaving limited funds for new acquisitions. Therefore, funds allotted for capital procurements should never be withdrawn.

The provision of unspent funds lapsing is responsible for the present tendency of expending maximum funds before the end of a financial year. In the case of MoD, the thrust shifts to booking of expenditure rather than spending funds on operationally emergent requirements. To prevent injudicious spending, it will be far more prudent to allow the unspent funds to be carried forward to the next financial year and added to the fresh allotment of the next year.

Considering that the small and medium enterprises (SMEs) constitute the backbone of the defence industry the world over and are at the heart of technology innovation, the government must hold their hand and extend fiscal incentives (including tax breaks) to them. Both the Defence Production Policy of January 2011 and DPP promise a fund to assist SMEs engaged in defence manufacturing. It must be operationalised at the earliest.

As is done by all developed nations, tax and duty structures should be rationalised to facilitate growth of the indigenous defence industry. Select defence projects can be accorded the status of deemed exports.

Financial powers of the functionaries must be commensurate with the responsibility assigned to them. They should have full authority to spend the funds required to achieve the specified targets. For capital procurements, financial powers of the service chiefs should be further enhanced. For revenue expenditure, powers should be increased at all echelons, both with and without financial concurrence.

Conclusion

Budgetary allocation by itself means little. It must be administered and overseen by an effective regime for obtaining optimum returns. Unfortunately, the current dispensation is grossly inefficient, bureaucratic and sluggish.

In addition to preparing the defence budget, the Finance Division exercises total financial control over its expenditure as well. It includes according financial concurrence to all expenditure proposals, account keeping and auditing. Unfortunately, performing of the above functions is totally beyond the competence of the Finance Division. There is a total mismatch – most Defence Finance officials are incapable of grasping minutiae of financial imperatives and are ill-equipped to perform defence economic advisory functions.

There is an urgent need for India to have a specialist cadre of experts who are proficient in various disciplines concerning defence economic imperatives. They should be fully conversant with rational application of economic tools to help evolve contours of dynamic linkages between well spelt-out strategic objectives and allotted resources for most advantageous results. They should also be capable of developing indigenous models for performance evaluation criteria, duly supported by methodological research support. The role of the present cadre of the Indian Defence Accounts Service should be restricted to the provision of accounting cover and audit, as hitherto fore.

To sum up, the forthcoming budget must adopt a three-pronged strategy to initiate reforms to impart professionalism and objectivity to the defence budgeting process. One, likely availability of funds must be made known to MoD well in advance to facilitate formulation of realistic plans. Two, adequate funds must be allotted to the capital head to expedite modernisation plans. No funds should be withdrawn after allotment. Carry forward of unspent funds to the next financial year should be allowed. Finally, counsel of defence economic advisors must be made available to MoD, both for the preparation of defence budget and to ensure that resources committed are applied optimally to achieve national security objectives.*****

  

Will offsets bring technology to India?

Will offsets bring technology to India?

(Global Defence and Offset Review 2014)

Major General Mrinal Suman

Technology is the engine that drives the growth of a country’s industrial prowess. In the case of the defence industry, technology acquires additional criticality as modern defence systems are highly complex and technology intensive. Moreover, they suffer from rapid obsolescence. India’s failure to keep pace with technological advancements is responsible for the current dismal state of the indigenous defence industry. Self-sufficiency in defence production can never be achieved unless India masters cutting-edge technologies.

Undoubtedly, all efforts must be made to upgrade technologies through the indigenous research and development route. However, it is a very time-consuming process and reinventing the wheel is no solution. Therefore, indigenous efforts must be supplemented by importing key technologies and thereafter using them as jumping boards for developing higher levels of technologies indigenously.

There are three ways of obtaining required technology from abroad. One, by purchasing it from the willing sellers and India has been adopting this route through the ‘Buy and Make’ procedure. Under this, a limited quantity is purchased from a foreign vendor in a fully built-up condition and the bulk quantity is manufactured in India through the transfer of technology (ToT). Although India has been following this course for decades, it has failed to upgrade the Indian technological base – foreign vendors continue to provide key components and sub-assemblies to Indian manufacturers for assembling the systems. Resultantly, there is little infusion of the latest know-how.

The second option is to obtain technology by inviting foreign vendors to invest in the Indian defence industry through joint ventures. India opened the defence industry to the private sector in May 2001, allowing 26 percent Foreign Direct Investment (FDI). The policy has been a total failure as prospective foreign investors view it to be highly dissuasive in intent and content – a licensee has no control over the enterprise; he can produce only the licensed products and in the sanctioned quantity; he can neither diversify nor enhance production; the Government can give no purchase guarantee; and the licensee will have no open access to other markets including exports.

The third, and perhaps the most potent tool available to India, is to seek technology against offsets. Being the largest importer of conventional weapons in the world, India possesses enormous leverage to demand required technologies. Foreign technology majors can be coerced to transfer their cutting-edge technologies by making award of high value contracts contingent to the offer of such technologies. Attractive multipliers can be applied to key technologies to provide necessary incentive to vendors to earn higher offset credits.

The term ‘technology’ does not convey know-how in absolute terms. It denotes a package of multiple sub-technologies that go into the making of a product or a defence system.  As most defence manufacturers are systems integrators, sub-technologies belong to diverse producers.

Every technology package consists of multiple items. They fall in three broad categories. One, items with ‘complete transfer of technology’ are those for which complete expertise (engineering-manufacturing documentation to enable fabrication, assembly and test of item) is being provided by the main contractor. Two, items with ‘limited transfer of technology for maintenance support’ are those whose development and manufacture has been subcontracted by the main contractor to his vendors based on his procurement drawings/specifications. Finally, the items branded as ‘proprietary items’ and for which he declines to transfer the technology.

The Current Offsets Policy

Earlier, technology against offsets was being declined on the specious excuse that India did not have the wherewithal to price technology realistically. Interestingly, under the Defence Offset Guidelines of 2012 (DOG), technology transfer has emerged as the preferred avenue for discharging offset obligations. This can be construed as a paradigm shift in India’s approach towards offsets, changing the fundamental character of India’s defence offset policy.

As per DOG, foreign vendors can choose their Indian partners and discharge their offset obligations through any one or a combination of the following seven methods:-

a)   Direct purchase of or executing export orders for eligible products manufactured by, or services provided by Indian enterprises.

b)   FDI in joint ventures with Indian enterprises (equity investment) for the manufacture and/or maintenance of eligible products and the provision of eligible services.

c)   Investment in ‘kind’ in terms of ToT to Indian enterprises for the manufacture and/or maintenance of eligible products and provision of eligible services.

d)   Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and/or maintenance of eligible products and provision of eligible services.

e)   Provision of equipment and/or ToT to government entities engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including the Defence Research and Development Organisation (DRDO).

f)    Technology acquisition by DRDO in areas of high technology.

Hence, investment in Indian enterprises (both public and private sectors) can be made in kind in terms of ToT through  joint  ventures  or  through  the  non-equity  route  for  co-production,  co-development  and  production  or  licensed  production and/or  maintenance  of eligible  products  and  provision of eligible  services. ToT must cover all documentation, training and consultancy required. ToT has to be provided without licence fee and there can be no restriction on domestic production, sale or export.

Offset credit for ToT would be 10 percent of the value of buyback by the OEM during the period of the offset contract, to the extent of the value addition in India. The  concept  of  value  addition  will  apply  only  for  direct purchase/export  of  eligible  products. Value addition is to be determined by subtracting value of imported components and any fees/royalty paid. This provision will ensure that the technology offered is not outdated.

In addition to the above mentioned common clauses, DOG has made special provisions for the public sector and DRDO. Vendors can opt to provide equipment/ToT to government institutions and establishments engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including DRDO.  Augmentation of capacity for research, design and development; training; and education can be included.

High Technology for DRDO

This is really the key aspect of DOG. An exclusive provision has been made for DRDO to acquire technologies in ‘areas of high technology’. DRDO has made public a list of high technologies and test facilities that it seeks under offsets. The list is vast both in scope and depth. It includes sensors, nano technology, radars, fibre lasers, gunnery, solar cells, hypersonic flights, carbon fibres and pulse power network, amongst others.

Broad guidelines have been provided wherein the Directorate of Industry Interface and Technology Management (DIITM) in DRDO has been nominated to be the nodal agency for all matters related to technology acquisition. DIITM will service a multi-disciplinary Technology Acquisition Committee (TAC) of DRDO. The committee will process all technology acquisition proposals and make its recommendations regarding their viability and a fair assessment of their cost. TAC could seek the services of professional bodies, if required.

TAC may also call for a presentation and have detailed technical discussions with the vendor to understand various aspects of the proposal. Where necessary, the TAC may visit the vendors’ premises to make an assessment of the technology offered. TAC will make its recommendations based on the viability of the proposal, the technology implications, absorption capabilities and a fair assessment of the cost of technology. Recommendations of TAC will be incorporated in the report prepared by the Technical Offset Evaluation Committee while the commercial valuation will be incorporated in the report of the Contract Negotiation Committee.

If TAC in its assessment feels that the technology so indicated is already available and/or is of no further use, it may reject the proposal and intimate the same to the Technical Manager in the Acquisition Wing of MoD.

Offset credits will be assigned by the newly created Defence Offsets Management Wing (under the Department of Defence Production) after completion of the technology acquisition programme successfully, as certified by DRDO.  

Will the Policy Succeed in Getting Technologies?

Disappointingly, the procedure mentioned in the DOG is afflicted with serious infirmities that have the potential of becoming contentious and embroiling the whole procurement process in protracted controversies.

As stated above, technology acquisition by DRDO has been designated as the primary mode of getting critical technologies and vendors are allowed to fulfill up to 30 percent of their offset obligations through this avenue. This is a considerable proportion. Sadly, the policy has been framed without basic understanding of the dynamics of offsets.

To start with, the current dispensation is fraught with uncertainties. In case a vendor wishes to offer any technology to DRDO in part fulfillment of his offset obligations, he will face a number of imponderables. For the submission of definite technical and commercial offset offers, a vendor has to be confident that the offered technology would be accepted by DRDO. Further, he should know its assessed cost and the applicable multiplier. It is only then that he can calculate offset credits that he would earn.

Every technology transfer offer forms a part of the overall technical offset proposal and is submitted along with it, albeit in a separate envelope.  In case TAC rejects the technology offer due to redundancy or the indicated cost, vendor will have to rework his offset proposal afresh. The complete acquisition process will get delayed as technical evaluation cannot be started unless technical offset proposal is found to be fully compliant. Thus, procedure for the selection of high technology for receipt by DRDO is too convoluted to succeed.

It should be for the buyer nation to decide as to what technology to seek against offsets to fill a critical void. It is not the type of technology but its relevance that should dictate the selection. India has abrogated that right in favour of the vendors who are free to choose the technologies they wish to offer. The list of the technologies provided by DRDO is highly imprecise and contains open-ended descriptions of vast arrays of related technologies. Needless to say, every vendor will try to pass off low-end technologies that do not require export licenses and are cheap to implement. Thus technologies that flow to India will not be need-based.

Multiplier is a factor applied to the actual value of an offset transaction to calculate the offset credit value earned. It is a methodology of assigning weightage to different offset programmes to provide vendors with incentives to offer offsets in targeted areas. In the case of technologies, multiplier values are universally assigned on the basis of level, depth, criticality and exclusivity of the technology on offer. Unfortunately, Indian policy makers have rendered such a potent tool ineffective and purposeless by making multipliers usage-based.   

The Way Forward

Offsets cost a country considerable extra expenditure – between 10 to 20 percent of the contract value. Every foreign vendor amortises the offset expenditure by suitably factoring it in his price quote, prompting many to question whether demanding offsets makes sound business sense. Regrettably, India has failed to derive any worthwhile benefits from offsets so far. Two audit reports submitted by the Comptroller and Auditor General of India (CAG) in the recent past provide a rare glimpse of India’s offset regime. Management of the complete gamut of offset activities has been found to be highly flawed and wasteful.

Ideally, the highly powerful leverage of offsets must be exploited to procure those critical technologies that industrially-advanced countries are reluctant to sell. India should seek technologies in which it has made considerable headway but not yet mastered – commonly referred to as lacking ‘last mile connectivity’. Such technologies can be absorbed seamlessly and utilised across a number of systems.

Being the principal recipient of critical technologies, DRDO must spell out every required technology (including sub-technologies) in specific terms, prioritise them, indicate estimated cost and assign multiplier values. These aspects must be made known to all vendors well in advance to help them in the formulation of their proposals. Through a well-evolved system of multipliers, irresistible incentives should be provided to foreign vendors to offer technologies that India needs the most. Application of multipliers should be technology-based and not usage-based.

Finally, it is time MoD undertakes a fresh look at the entire offset strategy.  DOG is a highly convoluted policy documents due to the incorporation of special provisions for the public sector. It should be simplified by having a common set of provisions for both the public and the public sectors. MoD must rise above narrow extraneous considerations and recognise the fact that the private sector is a national asset and must be treated as an equal partner in our pursuit of self-reliance in defence production.*****